managerial risk and incentive

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1. Problem statement
The authors’ main focus is the sensitivity of CEO wealth to stock return volatility (vega). They find that the higher vega leads to riskier policies made by managers. Examples of risky policies are investment in research and development and high leverage. It indicates that vega is an incentive for executives to invest in riskier asset and more aggressive debt policy. Therefore, firms with high growth opportunities may want to increase vega to motivate managers to invest in high risk with positive NPV projects.
Another focus of this journal is the sensitivity of CEO wealth to stock price (delta). Equity-based compensation has grown so rapidly in recent years and raised delta. Delta is believed to align the interest of managers and shareholders because higher delta means that managers have to work harder to increase the share price so that their wealth also increases. By having a high delta, managers are exposed to more risk. Hence, managers may give up high NPV project if it is very risky. However, higher vega may offset the risk-aversion arise from high delta.
Based on this background, the authors’ main research question is whether higher vega leads to riskier investment and debt policy, and greater volatility of stock returns. The authors want to separate two opposite effects of vega and delta which are (1) the effect of compensation to investment and risk policy, and (2) the effect of those policies to the compensation of risk-averse manager.
Motivation & Literature Study
The theory behind this journal is the convex payoff theory which stated that manager’s pay is a convex function of profits if recipients get a greater increment in pay when returns are high. In order to get greater pay, managers will adopt...

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... vega put their investment from less risky capital expenditures to more risky R&D.
Since diversification decreases firm risk, it can be expected that higher vega will result in increased focus of the firm and hence less diversification. This hypothesis is supported by the regression results which indicate positive correlation between vega and Herfindahl Index, and negative correlation between vega and number of segments.
The hypothesis for the correlation between leverage and vega is that firm risk will increase if it has a high leverage. In observing the correlation between leverage and vega, the authors used book leverage as dependent variable because market leverage may fluctuate because of changes in stock performance rather than active managerial decision. The regression results are consistent with the hypothesis since leverage has positive relation with vega.

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